United States Court of Appeals for the First Circuit
160 F.2d 78 (1947)
Aldred Investment Trust (the Trust) was a mutual fund. The Trust was structured with the voting control vested in the owners of $150,000 in stock. The Trust was mainly funded by the holders of debentures, which contributed $6 million. These debentures operated like a bond; they are a promise to pay a fixed sum of money in the future with periodic interest payments until that date. Debenture holders are typically fixed-income investors seeking a safe and steady return. This type of structure has an uneven and misleading distribution of risk and reward. The stockholders have a great incentive to invest in speculative stocks because the stockholders receive all the profit over the promised interest payment. Because the stockholders have relatively low equity in the Trust, the potential return on the investment is enormous. Additionally, the risk is mainly borne by the holders of the debentures because of the size of their investment. The Investment Company Act of 1940 prohibited these structures but did not require the liquidation or reorganization of existing investment companies. Hanlon led the original control group of the Trust and was caught in fraud and self-dealing. The Trust became insolvent, and a receiver was appointed by the court to take possession and control of the property. Bailey (plaintiff) and a group of investors purchased the controlling interest. One of the speculative investments greatly increased in value, which made the Trust solvent again. The trial court then ordered the receiver to liquidate the Trust. Bailey appealed to the United States Court of Appeals for the First Circuit.
Rule of Law
Holding and Reasoning (Mahoney, J.)
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